There is no doubt that the American retirement system is working as it has and continues to help the majority of Americans build retirement security. Through the American retirement system, the poverty rate among elderly Americans has fallen from 30% in 1966 to 9% currently, which is the lowest among all age grades in America.
Also, the American retirement system has led to a seven-fold increase in amount of assets earmarked for retirement per household, since 1975. That fact remains true even after adjusting for inflation. Again, since 1975, the number of American retirees receiving private sector pension as well as the amount received has increased. According to the Investment Company Institute, about 80% of working Americans and those close to retirement have accrued retirement pension benefits and/or retirement assets.
The internet has made the world a global village and it is very easy to know and learn from what works elsewhere. So, what can Nigerians and the government of Nigeria learn from the working American retirement system? Here are a few things.
Tax treatment of retirement savings matters
One lesson that can be learnt from the American retirement system is that tax treatment of retirement sayings matters a lot as it acts as an incentive to save for retirement. The United States uses tax deferral to incentivize employers and employees to put some money aside for retirement. Tax deferral has been the main factor the has and continues to fuel the US retirement market, so much that, employees seeking employment look for employers that offer retirement benefits. The lesson that this teaches is that tax treatment encourages high participation in the retirement market.
Setting appropriate contribution limits
Another lesson worth learning from the American retirement system is that setting appropriate contribution limits is important to the success of retirement savings. While it is good to encourage retirement savings by granting tax incentive, it is important to limit such contributions so as not to allow contributors to use the contributions as tax avoidance tools. However, the limits should not be set so low as to stunt contributors’ ability to save adequately for retirement and invariably affect the growth of the retirement market and assets. In the US retirement system, older workers are allowed to make larger contributions, called catch-ups. So while the US limits contributions, it also grants concessions for those nearing retirement age to save more.
Another factor that has contributed to the growth and success of the American retirement system and one that is worth learning is that limited access to retirement helps increase accumulation over time. Access limitation entails that the participants are not permitted to withdraw from their retirement savings accounts at will.
The United States uses tax rules to enforce such restrictions or limited access. For example, when you withdraw from your retirement account before the age of 59 and half, you pay a 10% penalty unless such withdrawal is due to certain allowable financial hardships or as a means for a first time home purchase, among others. Participants are allowed and encouraged to take loans on their retirement accounts rather than outright but premature withdrawals.
One characteristic of the US retirement plans is the ability of participants to choose from investment options aimed at providing diversification and covering a range of investment risks and returns. While that has led to the growth in the US retirement assets and markets, it may not be a good lesson to learn by Nigerians because many of Nigerian pension fund participants lack the investment related prowess and financial literacy required to make meaningful investments choices.
However, those that are already investment savvy should be given the option to choose. Allowing participants to choose does not imply that pension fund managers’ fiducial responsibilities of selecting and managing the pension funds prudently, should be sacrificed on the altar of participants’ ability to choose. To some extent, the Nigerian pension system meets this choice characteristic in part, by allowing participants to transfer from one pension fund administrator to the other during the transfer windows.
According to the Investment Management Institute, “for retirement savers to succeed, it is important to have clear disclosure of plan rules and investment options.” The area of disclosure, which bothers on transparency, is one that Nigerians should learn from and imbibe. While there may be disclosures on pension plan rules, there is not as much disclosure on choices. The US Department of Labor, DOL, which oversees employer-sponsored defined contribution plans, which are like the Retirement Savings Accounts in Nigeria, requires that plan managers provide participants with an annual notice that embodies information on fees, investment or position holdings. Also, “mutual funds, which are often held through retirement accounts, are regulated by the Securities and Exchange Commission (SEC) and provide extensive disclosure,” according to the ICI.
There is hope
The Nigerian pension fund industry is growing impressively and there are lots of room for more growth. If we can learn the things that work in places where retirement assets and markets have hit the sky, the Nigerian retirement industry will get much closer to hitting the sky too, in no distant time.